Moving clients out of unsuitable investments can be a valuable service, but are the costs and regulatory barriers proving too high?
Switching a client’s funds takes time and, just as importantly, money. Deciding whether to go ahead with replacement investment business can be a lengthy and challenging process.
Money Marketing asked advisers to share their experiences of how they weighed up whether a client’s existing investments were worth moving when they first stepped through the door.
Getting the risk right
Rowley Turton director Scott Gallacher estimates that as many as a quarter of clients who come to him with existing investments have unsuitable portfolios.
“It’s rare that they’ve been victims of scams, though that does happen,” he says.
While a knee-jerk reaction to a disappointing investment plan might be to look for the way out as soon as possible, sometimes, upon closer inspection, it turns out that the investment outlook can be improved using the funds and tools within the existing portfolio.
When a retired civil servant approached IFS Wealth & Pensions’ Alan Chan, the client had been underwhelmed by the lack of communication from her existing adviser.
Initial discussions between Chan and the new client quickly revealed that she had always wanted to invest ethically but was never made aware she could, despite the fact it was very important to her.
Chan says: “We investigated her existing platform, which was not one that we used on a regular basis, and it had a sufficiently large fund range, particularly for ethical selections.
“We recommended that the client stay with the existing platform provider and simply conduct an internal fund switch instead to an ethical portfolio that we built for her to match her risk profile.
“We could then continue to provide her with ongoing advice using that platform. We felt that there was no financial benefit for the client to change providers.”
From Gallacher’s experience, the most common reason solutions are a poor fit is that portfolios have become outdated and are much higher-risk than the client would be comfortable with today.
Gallacher says that in such cases, it might prove a complicated task to get a client to agree to take them out of their existing investments.
He says: “They’ve typically had higher returns to date, due to the higher risk the portfolio has taken, and they aren’t always willing to accept the reduction in potential returns that comes with a lower-risk portfolio.
“It can take quite a while to educate the client of the risks and help them to understand that they risk giving up all those excessive returns by panicking in the event of a major market crash.”
Gallacher adds: “Provided the client agrees with the need to make changes, we would then investigate whether or not it’s best to retain the existing product, albeit with fund changes, or whether it would be better to transfer to an entirely new solution. Obviously, ongoing costs of the new and the existing arrangements would have to be considered, along with any transfer costs.”
Darren Lloyd Thomas
Managing director, Thomas & Thomas Finance
I think it is important that you charge for strategy and that you won’t be paid for transferring. I have no time for the practice of contingent charging.
It is important you are able to charge your clients for the work you are going to do, that the fee is a fair fee that reflects your time, effort and risk, and that the client is under no illusion you are going to do your best for them and then give them a clear picture on whether they should keep or sell investments and why.
If they are paying you for financial planning but not to actually do the transfer, you would do the transfer only when it is the right thing and there is no conflict of interest.
We don’t like to give advice where there are transfer penalties but it obviously depends.
If it is a very small penalty, it might be worth it, but we have to build it in our record then.
Counting the cost
When it comes to measuring whether moving an investment pays off compared to the cost of the transaction, there is no one-size-fits-all rule. Shore Financial Planning director Ben Yearsley lists his deciding factors in whether or not to move: “I suppose the honest answer is it depends on how bad their existing portfolio is when looking against how we think they should be positioned.
“If the investments are all tax-wrapped, it’s a fairly easy thing to do and while I wouldn’t say the costs are minimal, they are reasonably small in the overall scheme of things, with time out of the market the biggest opportunity cost.
“A bigger problem arises when the investment solution isn’t tax-wrapped, for example in an Isa or pension, and there is a large capital gain which would probably be taxable.
“You then have to sit down with the client and work out with them what is the best course of action.
“Their existing portfolio might be so unsuitable you decide to move it immediately and take the capital gains tax hit.
“Alternatively, you might decide to move it over a few tax years, utilising annual CGT allowances.
“The honest answer is that there isn’t a hard-and-fast rule. It’s about assessing how appropriate or inappropriate their existing portfolio is and how quickly they should move out of it. Ultimately, it’s up to the client if they want to pay a CGT bill.”
Meeting the needs of values-driven clients
We often meet clients who have already been working with another adviser. SJP is one that comes up a lot. Clients have often been told that investing in line with their values is not possible, or will mean they have to give up returns.
Most advisers nowadays work with a buy list of funds or a centralised investment proposition, so have to undertake a lot of extra work to create a portfolio that suits values-driven clients. They then have to continue to monitor that portfolio. This is time-consuming and expensive for an adviser not expert in researching the area. If the adviser does not share their client’s way of thinking, they will attempt to dissuade them.
SJP has one sustainability fund, which is 100 per cent international equities. To have a diversified portfolio, the client needs to include other SJP funds which don’t benefit from any screening process.
We often work with clients who are disappointed by the impact options their current manager has provided (or indeed told them they can’t have). We look at the costs of their current solution, plus any costs involved with transferring, to make sure clients won’t be disadvantaged by moving. If the portfolio is outside a pension or Isa, we also look at the capital gains position. In some cases, we can process a transfer in specie, in order to avoid taxable gains.
There are very few instances of exit penalties now; typically it will be an SJP client and we have to weigh up the pros and cons of paying these in order to move. SJP can’t offer an impact portfolio, so it’s impossible for it to meet a client’s objectives.
However, if the exit charge is at the 6 per cent end of the scale, we’d advise the client to wait before moving. Even with lower fees, it would be difficult to recoup that.
Jeannie Boyle is director at EQ Investors
When a client with an unsuitable investment complains to the Financial Ombudsman Service and their claim is upheld, the FOS usually asks the firm that gave the unsuitable advice to compensate them by calculating the difference between the unsuitable investment and one that would have been suitable.
In cases when advice on how to fix an unsuitable solution is needed, the FOS has ruled in some instances that the client should be compensated for the cost of putting things right too.
In a 2013 FOS case involving St James’s Place, ombudsman Doug Mansell was not convinced that a client – Mrs A – benefited from switching her investments from an existing provider to a more pricey in-house one recommended by an SJP-
The FOS ordered the firm to compensate the client, based on the difference between the original suitable investment plan and the more expensive in-house offering.
Shoehorning clients into in-house funds was the FCA’s concern when it conducted a replacement investment business review seven years ago. In the run-up to the RDR, the regulator foresaw many advice firms coming up with their own centralised investment propositions and predicted them wanting to move their clients to these newly-created investments, offering guidance on how to keep fund-switching suitable.
The most commonly cited reason behind switching funds is cost. When moving a solution to a more expensive one, advisers must make a clear case that the extra cost of the proposed fund is justified.
Even when it is the other way around, and the proposed investment is cheaper, it is still a laborious process to come up with a detailed cost comparison analysing the existing and proposed investments.
The regulator expects advisers to calculate the final cost of moving (the initial cost and – if applicable – exit fees), but also a detailed cost of the new investment trading charges, as well as any tax considerations.
Potential barriers to switching between two sets of portfolios could also be a possible deal-breaker when it comes to mergers and acquisitions.
Advice firms looking to acquire other businesses are inspecting their target companies’ investment propositions to see if they are the right match, says investment consultancy Gbi2 director Graham Bentley.
Bentley says: “I have been asked to write reports for target companies’ propositions, and then report back on how well these propositions would fit and, in particular, whether there would be potential problems for clients trying to move from, let’s say, one type of portfolio arrangement to another.
“The acquiring business has very high on their agenda the importance of how well their existing proposition will match that of a target company.”